States turn federal tax credits into cash for would-be homebuyers

May 5th 2009

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How do you turn a tax credit into a cash benefit that will have the power to stimulate the economy and improve lives? That's the task that 10 or more states are taking on, in an effort to make the recently passed federal $8,000 first time homebuyers credit effective.

The credit is available to first time homebuyers, defined as an individual who has not owned a home in three year period prior to the purchase.

Eligible buyers must buy a principal residence – new or resale -- on or after January 1, 2009 and before December 1, 2009.

The purchase date is defined as the date of closing and property title transfer.

The tax credit is equal to 10 percent of the home's purchase price, up to a maximum of $8,000.

Income limits apply in order to get the full credit available: for single taxpayers, $75,000 and $150,000 for married taxpayers. Above those limits, there is still some credit available, depending on the buyer's modified adjusted gross income.

Claiming the credit involves filing IRS Form 5405 with your federal income tax return. This form determines the credit amount, and then carries the credit to your 1040 return. No pre-approval is necessary for buyers who qualify within the income limits above. That means that those eligible for the credit will have to wait till they file their 2009 federal income tax returns and receive their refunds. Buyers can also adjust their payroll withholding or their quarterly tax payments, using guidelines in IRS Publication 919. Or, they can amend their 2008 returns to get the credit earlier. For those who amend, the purchase is treated as if it occurred on December 31, 2008. The ability to amend depends on the modified adjusted gross income earned in 2008.

Apart from amending a 2008 return, homebuyers wishing to take advantage of the credit have to have some other way to come up with the funds in time to meet the November 30th deadline... and that isn't easy. In Washington state, the Washington Realtors Association conducted a study which showed that about half of would-be homebuyers cannot save enough to come up with the down payment and closing costs... thus locking them out of taking advantage of the $8,000 credit and the current low prices and low interest rates. That's a problem that several states are seeking to address by monetizing the $8,000 credit.

Prior to this credit, Washington already had a tax credit bridge loan program for buyers through the Housing Finance Commission. Now they are working on a plan to use this tax credit to expand the existing program. State Treasurer James McIntire is hoping to get a public-private down payment plan started that would make assistance available to more people. This would involve depositing $25 million in state funds into an interest-bearing account in an FDIC-insured bank. The bank would then set up revolving lines of credit which the State Housing Commission would be able to use to expand its efforts. In addition, the Washington Realtors Association is kicking in $400,000 to backstop against future unexpected losses.

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McIntire is working with the federal government to find a way to have tax credit funds paid to the state instead of to the taxpayers who qualify for the credit. This would ensure prompt repayment and give the state the ability to turn the money back around to help other eligible homebuyers before the November 30th deadline.

Missouri was actually the first state to address the need to help homebuyers with special loans, known as "tax credit advances." The advance - which is technically a lien - can be for up to six percent of the home's price. Borrowers have until June 2010 to repay the loan, giving them plenty of time to file their 2009 tax returns and get their refunds. What happens to borrowers who can't repay? The advance becomes a traditional second mortgage, which comes with a fixed interest rate, one-half percent higher than their first mortgage rate.

Colorado has a similar program, called "Jumpstart." Jumpstart requires homebuyers to also complete free homebuyer education classes to qualify. The credit advance, which takes the form of a second mortgage at zero percent interest, requires no payments if it is repaid by June 30, 2010. If not repaid by that date, the second mortgage interest rate jumps to 8 percent for a 10 year term.

The Delaware State Housing Agency provides up to $10,000 in down payment and closing cost assistance. It has also lowered its 30 year fixed rate to 5.5 percent with zero origination points.

The New Mexico Mortgage Finance Agency provides first time homebuyers with loans of 8 percent of the home's sale price or $6,500, whichever is lower, to cover the down payment and closing costs. This loan is interest free if repaid by June 30, 2010.

Pennsylvania's Housing Finance Agency makes available loans to cover down payments and closing costs, with a second mortgage for the lesser of 10 percent of the purchase price or $6,000 for new construction, or $5,000 for existing homes.

First time homebuyers in Tennessee can receive 3.5 percent of the purchase price through a second mortgage loan from the State Housing Development Agency. This type of loan is interest free until June 1, 2010. To qualify, borrowers must meet credit requirements and complete homebuyer education courses.

The most recent state to come up with a tax credit advance program is Kentucky. Kentucky Housing Corporation has set aside $5 million to fund the loans, which can be as high as $4,500 in $100 increments, and must be repaid by July 1,2010.

Other states – including Idaho, New Jersey and Ohio - are also reportedly working to develop ways to monetize the federal tax credits in order to maximize the number of people who can take advantage of the opportunity. IRS Commissioner Doug Shulman and other IRS officials are reviewing state requests such as the one from Washington State and from Charles McMillan, president of the National Association of Realtors to facilitate the rapid repayment of tax credits to state programs. If the federal tax credits are going to be effective, states need to turn the money around as quickly as possible so they can lend it back out again to more waiting buyers.